This post is not about Austrian economics, a field I know relatively little about. Rather it is a response to dozens of comments I have received by people who claim to represent the Austrian viewpoint. More specifically, it is a response to the claim that the 1929 crash was caused by a preceding inflationary bubble. I will show that the 1920s were not inflationary, and hence that there was no bubble that could have caused an economic slump which began in late 1929.

1. Inflation as price change: Let’s start with the obvious, the 1920s was a decade of deflation; prices fell. Indeed the 1927-29 expansion was the only deflationary expansion of the entire 20th century. That’s right, believe it or not the price level actually declined during the boom at the end of the 1920s.

2. Inflation as money creation: At this point commenters start claiming that inflation doesn’t mean rising prices, it means a rising money supply. I think that is absurd, as that would mean we lack a term for rising prices. But let’s assume it’s true. The next question is; which money? If inflation means more money, then don’t you have to say “base inflation,” or “M2 inflation?” After all, these quantities often go in dramatically different directions. Since the internet Austrians seem to blame the Fed, let’s assume they are talking about the sort of money created by the Fed, the monetary base. In January 1920 the base was $6.909 billion, and in December 1929 it was $6.978 billion. Thus it was basically flat, and this was during a period where the US population and GDP rose dramatically. The broader monetary aggregates rose significantly, but the government didn’t even keep data on M1 and M2 until fairly recently. No one in the 1920s thought the Fed should be targeting aggregates that didn’t even exist.

3. Housing inflation: There was no housing bubble in 1929, so there was nothing to burst and cause a depression.

4. Asset inflation: There was a stock price boom and crash, but we saw a crash of almost identical magnitude in 1987, and it had zero impact on the economy. In any case, it would be odd to call rising stock prices “inflation,” because none of these internet Austrian commenters call falling stock prices “deflation.” Stocks did very poorly during the 1966-82 period, yet I don’t see internet Austrians calling America’s Great Inflation a period of “deflation.”

5. The price of gold: Lots of modern internet Austrians focus on soaring gold prices as an indicator of inflation. If we are going to use gold prices as a proxy, then here are the inflation rates for each year of the 1920s: 0%, 0%, 0%, 0%, 0%, 0%, 0%, 0%, 0%, and 0%.

6. NGDP: Ah, now we are talking. I wish the term ‘inflation’ was used for rising NGDP, not rising prices. And of course Hayek favored a stable NGDP. If that’s what they mean by ‘inflation,’ then they can claim a meager victory for the 1920s, but very meager. NGDP was (according to estimates of Gordon and Balke) $95.98 billion in the first quarter of 1920, and $100.92 billion in the 4th quarter of 1929. That’s an increase of roughly 5% over 10 years, or about 0.5% a year. This means NGDP per capita was falling sharply, as the US population rose by more than 15% during the 1920s. I.e. NGDP per capita did much worse in the 1920s than it has in Japan during an 18 year period where total NGDP actually fell. In fairness, there were sub-periods of faster NGDP growth, such as the 3% annual growth between the 1926:3 and 1929:3 cyclical peaks. But that’s still far below average for the US, and thus I have trouble imagining how it could trigger the severe economic slump in late 1929.

And by the way, interest rates were not particularly low during the 1920s, particularly when you consider that it was a period of deflation. So no one can seriously claim the Fed was following a low interest rate policy.

In my view monetary policy during the 1920s comes closer to the Austrian ideal than any other recent decade. Then in the early 1930s we had deflation by almost any indicator (prices, NGDP, M1, M2, stock prices, etc) and the economy did poorly. Too bad the Fed didn’t try to keep NGDP at $100 billion (as Hayek’s policy rule would have called for), instead of letting it fall to less than $50 billion in early 1933.

Austrian monetary economics has some great ideas–most notably NGDP targeting. I wish internet Austrians would pay more attention to Hayek, and less attention to whomever is telling them that the Depression was triggered by the collapse of an inflationary bubble during the 1920s. There was no inflationary bubble, by any reasonable definition of the word “inflation.”

PS. I hope to do much less blogging in December, as I will be quite busy with various other tasks. Of course if Europe collapses . . .

Scott, as I mentioned in your just prior Von mises post, the impetus for tightening came from the gold cover ratio.

Second, the boom which the austrians refer to is a period where the market rate of interest is below the natural rate. I don’t see what inflation has to do with it except as being a reason why the market rate is eventually tightened. In the 20s, the gold cover ratio was a much stronger driver of policy.

Scott, you might be interested in this interview with Joseph Salerno from 1996 over at the Mises institute:

“Besides, it turns out not to matter in Rothbard’s theory. Including life-insurance policies, the increase in Rothbard’s money aggregate between mid-1921 and the end of 1928 totaled about 61%, yielding an annual rate of monetary inflation of 6.5%, compounded annually. Leave them out, and we get 55% over the period, or 6.0% per annum. For comparison, in the highly inflationary 1970s, the money stock grew at an average annual rate of 6.35%, including the double-digit Carter years.”

Anyhow you seem to acknowledge this point yourself here as well: “The broader monetary aggregates rose significantly, but the government didn’t even keep data on M1 and M2 until fairly recently. No one in the 1920s thought the Fed should be targeting aggregates that didn’t even exist.”

I therefore don’t think you can claim that you’ve shown that there was no money creation/inflation in the 1920’s according to #2.

This is an interesting topic, and I’m glad to see a mention to distinguish between “Austrian economics” and “Internet Austrianism.” These can be two very different things; and not every critic always makes that distinction.

I wonder if in your research of the Great Depression you had the chance to read Benjamin Anderson’s “Economics and the Public Welfare” (1949) and what you think about it.

Certainly Rothbard’s “America Great Depression” is not the only, and I doubt the best, “Austrian reference” for this episode.

I think people are getting the wrong price signal from gold. soaring gold in terms of a commodities basket, say copper means deflation. soaring gold in terms of wages means deflation. i.e. it takes more and more hours or tons of copper to buy 1 oz of gold.
I am using deflation in the sense that real wages and prices need to be adjusted down due to excess capacity. Since wages (and prices) are rigid, easier for gold to go up (or: for the dollar to buy less gold).

Of course, you can’t fault “internet Austrians” from not being able to engage you on the level of your average Peter Boettke, but on the other hand I am thankful that blogs don’t yet have entry exams and stuff. (Well, maybe DeLong’s does, but still… )

I still don’t understand why exactly the Great Depression happened. Even after reading “Lords of Finance”.

In the US, prior to the crash, economic policy was great, the Fed was ignoring the calls of some to tighten monetary policy and stem the stock market “bubble”. In fact, if anything the Fed had signaled a year prior that it was willing to cut rates even in the face of a roaring stock market (despite Hoover’s objection and mostly to please Norman Montangue’s call to “recycle” gold back to Europe).

I guess according to Market Monetarism it doesn’t matter why it happened, the Fed should not have allowed NGDP to fall so much, so fast. But why did NGDP start falling so much to begin with? Was something happening that increased demand for the medium of exchange?

I liked Scott’s explanation for 2008 crash. Bad macroeconomic policy (immigration, minimmum wage) and oil shocks cause subprime loans to go belly up. This increases the demand for the medium of exchange to which the Fed does not respond to with enough vigor and the expectation sets that the Fed doesn’t care about the market’s demand for the medium of exchange or NGDP growth and it becomes a self-fulfilling prophecy and everything crashes.

But in the case of 1929 America, I just don’t get what went wrong? In fact, it seems to validate those who think these things are due to financial bubbles crashing. The stock market went up too much, too fast and then it crashed causing the Great Depression. It’s a mystery to me.

“The second point is that up to 1927, I should indeed have expected that””because during the preceding boom period. Prices did not rise but rather tended to fall””the subsequent depression would be very mild.But, as is well known, in that year an entirely unprecedented action was taken by the American monetary authorities, which makes it impossible to compare the effects of the boom on the subsequent depression with any previous experience. The authorities succeeded, by means of an easy-money policy, inaugurated as soon as the symptoms of an impending reaction were noticed, in prolonging the boom for two years beyond what would otherwise have been its natural end. And when the crisis finally occurred, for almost two more years, deliberate attempts were made to prevent, by all conceivable means, the normal process of liquidation. It seems to me that these facts have had a far greater influence on the character of the depression than the developments up to 1927, which from all we know, might instead have led to a comparatively mild depression in and after 1927”

As Gene Callahan said: “That would be Rothbard” Rothbard’s “America Great Depression”. Rothbard’s monetary aggregate should be what Sumner addresses an argument to. Picking out a strawman internet austrian and burning it is not adequate.

disclosure: I want the Fed to take up Sumner’s NGDP targeting. I think commodities would react more bullishly than Sumner seems to think. However, I do not think the Fed or it’s defenders have provided any adequate reasons for not implementing Sumners version of NGDP targeting…the longer they ignore his suggestions the more they prove they are not what they say they are(intellectualy honest technocrats trying to help the median citizen to the best of their ability). The only real reasons not to implement or try NGDP targeting are austrian in nature and we know that austrians are not in power, therefore the Fed is run plain old corrupt dicks. I look for the fed to eventually adapt a bastardized NGDP targeting scheme that gives them cover while they remain corrupt.

Economies always have various kinds of mild shocks. There was a subprime mortgage bubble in 2007, and so it’s no surprise that some investors would eventually lose some money in that narrow industry.

The answer to your question is: it doesn’t matter so much what sparked the flame. There are matches going off all the time. What matters is whether the Fed allows any particular match to spread to the overall economy. The Fed has the power to keep the local industry shock contained.

You should worry much less about 2008 and 1929, and you should investigate much more the non-recession in 1987. The stock market crash in 1987 was as big of a match as anything you’ll find in the other cases, but it was hardly noticed in the overall US and world economy.

You write: “The stock market went up too much, too fast and then it crashed causing the Great Depression.”

If you believe that, then you need to explain why the 1987 stock market crash didn’t also cause another Depression.

Sadly the data for the “true money supply” doesn’t go back to the 1920s. I did take a look at data for the last five years, which shows a big increase in the TMS starting around 2008. That’s not so surprising, but what is strange is that this increase in TMS hasn’t translated into a major increase in prices. No doubt this is because of the massive offsetting increase in productivity that started in 2008.

The Austrians tend to zoom in on bank credit; if it is growing briskly, they seem to beleive the policy rate is below the natural rate, and the converse. Strangely, when the Fed doubled reserve requirement ratios in 1936/7 and also stopped sterilizing gold inflows, it was due to fears that excess reserves would ** eventually** seep into loans and investments at commercial banks. In other words, a “preemptive tightening”. It was a Fed/Treasury superfail that the Austrians bear partial blame for.

The Austrians tend to zoom in on bank credit; if it is growing briskly, they seem to beleive the policy rate is below the natural rate, and the converse. Strangely, when the Fed doubled reserve requirement ratios in 1936/7 and also stopped sterilizing gold inflows, it was due to fears that excess reserves would **eventually** seep into **excessive** loans and investments at commercial banks. In other words, a “preemptive tightening”. It was a Fed/Treasury superfail that the Austrians bear partial blame for.

“Too bad the Fed didn’t try to keep NGDP at $100 billion (as Hayek’s policy rule would have called for), instead of letting it fall to less than $50 billion in early 1933.”

When exactly did Hayek come up with this policy rule? In the early 30s he was a dogmatic inlfation phobe who thought eveyone should stay on the gold standard.

‘Austrian monetary economics has some great ideas-most notably NGDP targeting.”

While I understand that NGDP targeting is an idea that you have popularized I certainly don’t understand when the Austrians made this their idea either. The Austrians and this was true of Hayek when the Depression started take a dim view of monetary expansion holding it responisble for cycles of boom-bust. Their optimum policy seems to be reveries about the old gold standard when “hard money” regined.

I don’t have time to go look up all the data right now but I think the stats might be misleading if you use 1920 as the starting point because the was a year of very high prices following “high NGDP” growth during and after WWI. Prices fell sharply right after 1920 and price inflation stayed tame throughout the 1920s. What us Austrians point to as triggering the late 1920s boom bust was Strong’s decision to devalue the dollar in order to support the British pound which the British ha pegged too high against gold. I think that happened in 1927.

Hayek explicitly refers to “stabilize” MV in “Prices and Production” in pages 122-123.

Hayek’s “Denationalisation of Money” was a kick-off for contemporary studies on free-banking, where a stable MV is a clear outcome of such system. See, for example, the works of L. White, G. Selgin and S. Horwitz.

Hayek explicitly called for constancy of what he called “the total money stream,” i.e. stabilization of nominal GDP.
He was a forerunner of NGDP targeting.
To keep “the total money stream” constant means expanding the quantity of high-powered money to offset any forces shrinking the broader stock of money, or any increase in hoarding.
We can fault Hayek personally for failing to stay on this message consistently in the early 1930s.
He himself later pleaded mea culpa on that.
But his explicit monetary policy norm – to maintain nominal spending, is clear, and sensible, and not “do nothing”.
It would have prevented the deflationary spiral of the early 1930s, if the Fed had listened.
It would be an improvement today over the Fed’s unanchored policy

“What us Austrians point to as triggering the late 1920s boom bust was Strong’s decision to devalue the dollar in order to support the British pound which the British ha pegged too high against gold. I think that happened in 1927.”

Yes. And Liaquat Ahamed wrote about just that and he seemed to imply that that decision caused the stock market “bubble” to roar even higher causing an even bigger crash.

That doesn’t seem to sit well with Scott’s idea that bubbles don’t exist. That’s why this is so perplexing to me.

By the way, the above does not justify the Austrian point of view. Since, as Austrians would attest, markets are super efficient, the market knew that the Fed was doing just that and so if it was truly something bad then the market should have crashed immediately.

That’s why the only way you can make the “bubble” argument is if you think markets are INefficient and wrong.

There’s a lot going on here. No single blog comment I make could ever account for the whole story. I don’t disagree with the mainstream about where the money has gone, I’m just of the opinion that it has been created and definitely does exist.

Most people say, “So what? NGDP hasn’t increased and neither have prices.” It’s a fair point to make, considering the paradigm they’re coming from.

My paradigm is different. That the economy hasn’t already felt what I see as inevitable effects of this kind of policy is hardly evidence against those effects.

Remember, “the economy” doesn’t grow or shrink – only individual incomes grow or shrink. Add it all up and you might have a positive or negative number, but at the end of the day, it’s individuals who count. If I borrow at 1% and invest at 3%, I’m “only” making 2% return – but I’m doing so with free money. It’s 2% that didn’t exist before.

That money is real money that comes from someone and gets invested in someone else’s business. My question to you would be: “Who are the ‘someones’ and why would an Austrian School economist consider them important?”

It’s the Chicago School that thinks markets are efficient not the Austrians. The basis of Austrian theory is that market participants can be mislead by credit expansion. Austrians think markets are efficient in the sense that I they are left free of coercion, mutually beneficial exchanges that happen in a free society tend to maximize utility.

Thank you Nicholas and Dustin. Are you saying that he was for this when he wrote Prices and Production? I will check pgs 122-23. My point is not that this would be an improvement over the 30s monetary policy or today but rather Hayek’s position.

If you say he was for it back as far as P&P then ok, but I don’t get why he became deflationist in the face the conditions that acutally required what he had already supported.

Though it’s not directly related why did the Chicago School ban him from their econoimcs department during his time there-it’s always been a curiosity of mine.

You say: “Remember, “the economy” doesn’t grow or shrink – only individual incomes grow or shrink. Add it all up and you might have a positive or negative number, but at the end of the day, it’s individuals who count.”

It’s individuals who count, but that doesn’t mean that aggregates aren’t important. The “true money supply” is an aggregate. So is inflation. Austrians will sometimes retreat to saying that aggregates don’t matter, without realizing that this would invalidate most of their talking points.

In looking at Larry White’s talking points where he says that Hayek was not about do-nothing panglossianism, that this is a straw man attack on him: take a look at this piece about Cassell http://www.dartmouth.edu/~dirwin/Cassel.pdf

I will quote from page 39 “At one point, Cassel (1931, 339) almost spoke directly to Hayek’s views:

“Many writers seem to regard as natural a fall of the general level of commodity prices such as the present, but as an inadmissible intervention in the development of things, any endeavour to check the fall or to raise the level again. Thus a policy of deflation is sanctioned as natural, but even the most moderate policy of inflation or even the smallest resistance to deflation is rejected as the devil’s work! Such an attitude is, indeed, not very reassuring for our economic future.”

“Cassel recommended that “No further time should be wasted in listening to those false prophets who, by their resistance to every endeavour to gain control over our monetary system, have helped to bring about, intensify and prolong one of the most disastrous economic catastrophes to which the world has ever been exposed.”

There was inflation, and later those who could influence events, seemed almost to conspire to do it badly.

Housing and stocks were both inflated in 1929, but you have to look closely.

Housing prices were under control, but housing starts were rocketing – from the postwar low of around $700 million to over $5 billion in 1919-1929. That’s twice the prewar average of around $2.75 billion and peak of around $3.25 billion [these are estimated from a graph, so they’re not exact].

Housing prices rose by around a third in nominal terms and were flat in real terms, both down substantially from the war period. In 1919 there was a housing shortage, since very few houses were built during the war.

Not surprisingly:

“Total mortgage debt outstanding increased from $9.35 billion in 1920 to $29.44 billion in 1929. In 1920, residential mortgage debt was 10.2% of household wealth; by 1929, it was 27.2% of household wealth”

That’s 30% of GDP. It doesn’t seem like much, but it’s twice the 1951 number. And, mortgage terms were 5 years or less, so loans had to be rolled over.

The stock market also on a tear. It went from 64 at the bottom of the 1919 recession down from 140 to almost 400. This was a reasonable price 14-19 PE depending on how you figure it (Fisher was right, except for utilities), but the rise was inflated by speculation on margin and leverage in investment trusts.

Would you call it inflation when prices are supported by reasonable values, but the stockholders are overextended? Certainly stocks rose faster than GDP.

First the Fed raised rates saying its intent was to curb speculation, then bad news arrived about utilities (they were overpriced, and there was a movement have local governments take them over), a very important market sector, prices started falling. There were several large declines in October, so the leveraged had just about run out of capital. When more bad utility news arrived, you see margin calls and forced sales (with no rules about naked shorts and a short selling uptick).

So the debt wasn’t as bad as 2008, but the housing and stocks markets were more vulnerable to a liquidity crisis.

So far this only adds up to 1987 but government interventions soon turned it into a depression.

Expelling 500,000 Mexicans (who must have contributed to GDP), the Smoot-Hawley tariff, a huge tax increase for the wealthy (from 25% to 63%)!, a check tax, increases in corporate and estate taxes, a balanced budget,interference with business (even a worthwhile change has an initial negative effect).

On top of this we have the Fed tightening in 1931 and 1932, the French vacuuming up all the world’s gold and the failure of Credit Anstalt.

Is it reasonable to look for a single cause, when all the players are doing their best to supply one.

We now understand that stress causes bad decisions. At a certain stress level people do stupid things and dig in their heels. It seems that in a major financial crisis there is not only an economic feedback instability, but a psychological one as well

But what exactly did the Fed did do after Ben died that would indicate that they were going to tighten monetary policy.

In the case of 2008, there were all those Fed meetings when Bernanke continued to express worry about supply inflation. To me the story of 2007-2008 makes sense from a market monetarist point of view. Events happened that increased the market’s demand for the medium of exchange. The market looked to the Fed to see if it would respond. It didn’t. The market fell a bit, looked to see if the Fed would respond. It still didn’t. The market fell some more. Looked to the Fed again. It STILL didn’t respond. Then the market’s expectations, rationally, changed severely and everything crashed.

What happened in the summer/fall of 1929 made no sense. Market was roaring upwards and then on a dime everything crashed.

Apparently after Strong died the Federal Reserve went on an anti-speculation drive, refusing to lend to banks deemed too “speculative”.

Excerpt from the article:

Under Miller’s influence, the Federal Reserve Board in early 1929 unleashed an evangelical crusade against stock market speculation. In keeping with the precedent Strong had initiated””a stable price-level policy, without heed to the latent gold standard””proponents of the RBD could proceed equally unconstrained by any “gold standard” (Hetzel 1985: 15). Fortunately for the record, Miller had the temerity to write an article for the American Economic Review in 1935, in which he lauded the Board’s anti-speculation policy after 1929, and recounted his role in promoting it (Miller 1935: 442-57).

Miller (1935: 453) claimed critically that Strong’s policies in the presence of stock market speculation “proved to be unequal to the situation . . . in this period of optimism gone wild and cupidity gone drunk.” The Federal Reserve Board’s “anxiety,” he continued, “reached a point where [the Board] felt that it must assume the responsibility for intervening . . . in the speculative situation menacing the welfare of the country.” Consequently, on February 2, 1929, the Board sent a letter, crafted mostly by Miller, to all the Fed Banks stating that the Board had the “duty . . . to restrain the use of Federal Reserve credit facilities in aid of the growth of speculative credit.” To accomplish this end, the Board initiated “the policy of ‘direct pressure’ [that] restricted borrowings from the federal reserve banks by those member banks which were increasingly disposed to lend funds for speculative purposes” (p. 454).

EVERYONE, Too many comments for detailed responses. Let me remind you that if you don’t think the bursting of an inflationary bubble is the “true” Austrian story, then this post is not for you. The post is aimed at numerous commenters who appear here claiming to be Austrians, and claiming that Great Depression was triggered by the bursting of an inflationary bubble.

I did not claim to correctly characterize the Austrian view.

Jon, You said,

“Scott, as I mentioned in your just prior Von mises post, the impetus for tightening came from the gold cover ratio.
Second, the boom which the Austrians refer to is a period where the market rate of interest is below the natural rate. I don’t see what inflation has to do with it except as being a reason why the market rate is eventually tightened. In the 20s, the gold cover ratio was a much stronger driver of policy.”

First, your comment has no bearing on my post. Second, there is no doubt in my mind that the huge increase in the world’s gold reserve ratio after October 1929 was the trigger for the Great Depression. It was a huge mistake, which ultimately led to Hitler taking power. So I agree gold was important. Third, interest rates were not below the natural rate, as generally defined by people like Wicksell, as that’s the rate that holds prices constant. And prices were falling.

Josh, A friendly suggestion: Don’t attach links without explaining why we should read them, otherwise we won’t. What is the punch line of the link?

Bob, You’ve got some work to do to get in that kind of shape.

Martin, I’ve shown there was no inflation as the term was defined at the time. I’ve shown that there was no alternative non-inflationary policy as understood by policymakers at the time, including those in the 1920s who claimed the Fed was too inflationary. It makes no sense to argue things were inflationary because M2 went up, if M2 didn’t exist. There are no policy implications. M2 was an idea invented much later.

Thanks Gene.

Brian, (blows on fingers) I’m ready! (blows on fingers again.)

corey, I can’t say, as I’ve only skimmed his work.

Nicolas, I have looked at that book, and perhaps will again. He has lots of good things to say, but I’m more a fan of his views on non-monetary issues, than monetary issues. Hawtrey has the best book on the Depression (The Gold Standard in Theory and Practice.)

dwb, Yes, but I hate to see terms like “deflation” used for the prices of individual goods, or the ratio of one good to another.

Ryan, They really should use a log scale, otherwise that graph’s tough to read. I also wonder what we are to make of those figures. Does the recent surge in money tell us what will happen to the economy? If so, what is the answer?
In my view changes in the stock of money can reflect either supply or demand shifts, hence the actual quantity of money is not very informative (except in the obvious cases of extreme changes–hyperinflation, etc.)

B, I’m afraid my snark is still pretty unrefined.

Ben, I agree.

Nick, Yes it was abnormally low. NGDP rose about 2% (total!) from 1930:1 to 1939:4. For all other decades it was much, much higher. If you like Hayek’s stable NGDP, the 1920s were about as good as it gets (obviously the 1930s were highly erratic.) Japan is also extremely Hayekian.

Liberal Roman, No, the Fed tightened monetary policy after Strong died in mid-1928 (according to the gold ratio) and tightened even more in late 1929. The Great Depression is easy to explain in technical terms–tight money. The tougher (political) question is why?

Greg, I call it “good deflation.”

Wonks, Because real GDP did well, for three reasons. First, the expected rate of inflation was far lower than today. And second, wages were more flexible (especially in 1921), and third, strong productivity growth led to some of the “good deflation.” All three reasons are very significant, they are all important. None apply today.

Rob, You said;

“And when the crisis finally occurred, for almost two more years, deliberate attempts were made to prevent, by all conceivable means, the normal process of liquidation.”

Greg Ransom is an expert on Hayek, and he continually points out that Hayek did not study US data very closely. The quotation you provide is spectacularly inaccurate. There was an ultra tight monetary policy after the crisis, by almost any reasonable criterion. The gold ratio rose sharply. The monetary base fell about 7.5% in the 12 months after October 1929, prices and NGDP plummeted. If he thinks the Fed tried and failed to prop up the US economy, he’s sadly uninformed. They were wrecking the economy. One can argue that Fed policy was easy during 1927-28, but not during 1928-29, and certainly not 1929-30.

Gabe, I’d rather respond to you than Rothbard.

I’d need to see publications from the 1920s that discussed Rothbard’s aggregate. Otherwise I have no policy counterfactual to consider.

Second, Suppose there was no Fed, and the gold stock and monetary base had stayed flat during the 1920s. And suppose this mysterious aggregate had increased. Would Rothbard call that “easy money?”

That what I think was Hayek’s take in Prices and Production. Probably, he wasn’t clear or strong enough (which I’m not sure it was so unusual at that time: see chapter 8 in Selgin’s “Bank Deregulation and Monetary Order”).

If you’re interested in Hayek’s evolution on monetary issues, see White’s “Hayek’s Monetary Theory and Policy: A Critical Reconstruction” in Journal of Money, Credit, and Banking (1999).

I’m not sure what you mean by “deflationist.” The problem is that relative prices should be corrected, for that the level of prices in itself is unimportant. To expand money supply with the objective of increasing aggregate demand does not solve this problem. However, when Hayek talks about keeping nominal spending constant (MV), that’s to avoid a monetary deflation. If money demand increases, provoking a fall in V, then Hayek’s suggestion is to compensate with an increase in M; but not to expand money supply as a means to increase aggregate demand.

So, he was not a deflationist in the sense of “freezing money supply”, only to the extent that relative prices need to adjust, which means that some prices have to fall (with respect to others).

Regarding Cassel’s point, I’m not sure that’s an accurate description of Hayek’s point. Again, maybe Hayek wasn’t clear enough, but a careful reading of his work doesn’t seem to point in the way of Cassel’s interpretation.

Scott,
I think that was an interesting post, but I think some adjustments are in order. So the Austrian theory is that easy monetary policy results in “the interest rate” being pushed below the natural rate, leading to faster growth in investment spending vs. consumption spending, the capital stock will grow larger than the economy “can sustainably support,” and that eventually monetary policy will tighten and cause a correction.

This really isn’t in terms of your NGDP analysis.

If I were to put this in NGDP terms, then the real natural rate (assuming stable time preferences) would be strongly correlated with the expected long-run growth. The expected output gap would be negatively related to the difference between the real rate and the real natural rate, while expected inflation would be positively related to the expected output gap. If the real rate equals the natural rate, then the expected output gap would revert to 0% and due to this the expected inflation would revert to long-run expectations.

That’s kind of like an NGDP target. So if NGDP is expected to grow faster than this number, then that could be equivalent to the interest rate being below the natural rate.

So if the long-run market expectation of prices is deflation, then natural NGDP growth might be negative and thus if NGDP is expected to grow 0% or slightly positive, then this might be consistent with easy monetary policy under the Austrian/Wicksellian story.

Blackadder, you score “gotcha” points, for sure, but you haven’t actually responded to the question I asked you. The money supply isn’t an “aggregate” in the same sense that individual income is an aggregate. One represents the numerical count of a single market good, the other represents the current spot-value of a potentially infinite number of goods and services. You tell me which one of those two is a valid aggregate. I’ll give you three guesses. Or am I still “retreating?”

Scott, my version of the Austrian view (the ‘internet Austrian’ view? 😉 is that the True Money Supply provides a measure of the level of credit expansion occurring in a given monetary region. The issue for folks like me is credit expansion, not money supply per se. Austrians suggest that credit expansion causes malinvestment. One would be tempted to call this a “Law” in the same sense that diminishing marginal utility is a “Law.” It’s not a “might happen,” it’s a “will happen.” The greater the credit expansion, the greater the malinvestment. This is a terrible waste of scarce resources that diminishes society’s ability to meet its own needs.

And the worst part is, credit expansion is purely the result of policy. It can be stopped any time we want it to.

Don, Yes, but in 1929 it wasn’t even an error of omission. They had a very active tight money policy–first raising rates sharply in 1928-29, and then reducing the monetary base sharply in the 12 months after October 1929.

Tommy, But surely the Austrians don’t want the Fed to target bank credit?

Mike, I don’t know the exact date, read George Selgin on Hayek.

John, You said;

“What us Austrians point to as triggering the late 1920s boom bust was Strong’s decision to devalue the dollar in order to support the British pound which the British ha pegged too high against gold. I think that happened in 1927.”

Strong never devalued the dollar.

You are right that the sharpest price declines were in 1921, but prices also fell in 1926-29.

Becky, The base declined about 15% in per capita terms.

Thanks for the info Nicolas and Dustin.

Liberal Roman, Strong did not devalue the dollar.

Peter, Housing starts are so far from the concept of “inflation” that I hardly even know what to say. Housing prices wouldn’t be a good measure of inflation, but I could at least imagine someone using that metric. But starts? That’s output, not prices. In any case, housing is like 5% of GDP, the idea that a central bank would be targeting housing starts makes zero sense.

We learned in 1987 that stock crashes have zero effect on the economy. Nada. Stocks move around erratically all the time, God help us if the Fed ever starts targeting stocks.

Bottom line is that if Austrians are going to call 1966-82 “deflation” then I’ll listen to arguments that the 1920s were inflationary. If not, then I won’t.

This post is not about what came after. I agree that Smoot Hawley hurt the economy, but the evidence suggests than modest tariff increases have very modest effects–not enough to cause a recession. And I certainly agree about French gold buying, and have published papers on the topic.

Statsguy, You said;

“And yet 1929 happened…”

No mystery there given the Fed’s very tight policies.

Jason, Actually all three of the greatest monetary economists of the 20th century blamed the Depression on Strong’s death (Hawtrey and Fisher being the other two.)

1. Austrians are making a HUGE mistake if they base their monetary theory on interest rates.

2. Interest rates were not low during the 1920s. If they want to claim they were below the natural rate, they need evidence. They certainly weren’t below the natural rate as economists understood the term at the time (from Wicksell.)

3. There is no natural rate of NGDP growth. There is no natural rate of any nominal aggregate. That’s a policy decision. I don’t see why positive NGDP growth would be easy money, even with deflation. Doesn’t RGDP usually grow at positive rates? I need a benchmark, and no one has given me one.

Ryan, Ok, but money and credit are two entirely different things. The Fed controls money, not credit. If I lend you money that’s credit–and the Fed isn’t involved.

I had thought that the Austrians blamed the Fed for an inflationary monetary policy during the 1920s. But I don’t see a plausible policy counterfactual that would have prevented credit growth. Surely you wouldn’t expect a 1920s Fed to be targeting “credit”, that was so far beyond it’s mandate as to be a non-starter, I doubt they even had data for total credit.

It would also help if someone would provide me with data for the “true money supply” that was published in the 1920s.

First, your comment has no bearing on my post. Second, there is no doubt in my mind that the huge increase in the world’s gold reserve ratio after October 1929 was the trigger for the Great Depression. It was a huge mistake, which ultimately led to Hitler taking power. So I agree gold was important. Third, interest rates were not below the natural rate, as generally defined by people like Wicksell, as that’s the rate that holds prices constant. And prices were falling.

I’m scratching my head wondering why you sound so pissed off. As for your point number three, price inflation is a long run consequence of holding the market-rate below the natural rate. The Austrian discussion of this point suggests that the interest rate affects production first, then prices–prices are a lagging adjustment. Perhaps you’ll claim that EMH make that impossible. I disagree. The natural-rate isn’t known; so its not known for certainty that the market-rate is being pushed below the natural-rate. That’s particularly true in the past when communication was more limited.

The gold cover is a good way to enter the Austrian story. Perhaps you don’t want to make that leap, fine, but if you want to argue the point you’re making here, you might get further if you made it clearer that the ABCT might not have anything to do with inflation at all. Just my two cents.

Thanks, Dr. Sumner, for going deeper into this topic that started with Austrian economics getting hammered by all kinds of conjecture with superficial plausibility. I have been flirting with it out of sense of curiosity, but also because the Austrians are the only ones who can envision the economy without the Fed. Given the level of seriousness regarding the current state of monetary affairs, it is at least worth some consideration.

If I were going to criticize the Austrians, however, it would be for the inability to articulate to the rest of us how we could cross the bridge from this world to theirs. I’ve wanted to know how practical it is to go that direction, but all I seem to get is sound bytes of propaganda and nothing that gives the warm fuzzy of being able to follow the golden thread of logic to the same conclusions when I ask. Add to that the twist of being an armchair historian, I am well aware of the peripheral political battles over money throughout most of the 19th century and subsequent effects, and view the claims that a gold standard would solve our problems with government intrusion and distortions in markets with a hefty dose of skepticism.

It’s easy to say ‘can the Fed’ but it can’t be done over night. There is so much complexity that has been built up around it that I don’t think anyone really understands what would happen trying to get from here to there. The point of doing it would be to get from this monstrous Fed-driven disaster to a world that works, not to just take a leap of faith that’s what would actually happen. We have seen what happens when the things we do with money change, it’s like the world as we knew it suddenly vanished. I want to know what the world looks like when we’re crossing that bridge, what we have to do to cross it, and what it looks like when we get there that is at least comparable to the historical record. It’s completely amazing that when I ask these questions, because I am seriously thinking about it, I never get a serious answer.

Read Book IV of Hayek’s _The Pure Theory of Capital_ for definitive evidence that Hayek does not:

“Austrians are making a HUGE mistake if they base their monetary theory on interest rates.”

But your statement is ambiguous — “interest rates” as historical phenomena and “interest rates” in theoretical / explanatory constructs are very different things, and, e.g. “low” rates can be very different things with opposed significance in these two very different things.

In other words, Historical interest rates can fail to have the significance an ignorant understanding of theory might mislead one to think they necessarily have.

Liberal Roman: most developed economies were on the gold standard. The Bank of France and the Fed took gold out of the monetary system, driving up the price of gold inside the monetary system, which drove up the price of money (since gold set the price of money) which drove down the price of everything else, and so people’s incomes. A significantly leveraged economy suffering an income crash (for debt, nominal income is what counts) leads to bankruptcies and bank failures in a disastrous downward spiral in economic activity.

The quicker countries leave the gold standard, which the Bank of France and the Fed had turned into a doomsday machine, the quicker they recovered from the Great Depression. (If they were not on the gold standard, they did not suffer it at all.) There does not seem to be much mystery to all this.

R. G. Hawtrey and Gustav Cassell accurately predicted the danger in the early 1920s and explained what was going on at the time. Alas, Hayek was a brilliant economist who brilliantly expounded the Austrian (the real one, not the internet one) theory of the business cycle at precisely the wrong moment. Alas, Keynes was a brilliant economist who decided to revamp macroeconomics in quite unnecessary ways, when a Swedish economist and a British Treasury official had already got it right. But a Swede and a bureaucrat were not nearly as well placed as Keynes-the-public-intellectual and brilliant (if not always entirely honest) rhetorician to capture the debate.

It is strange, how much people seem to want complicated or new, or complicated and new, explanations for grand disasters in preference to a simple one already available.

“The broader monetary aggregates rose significantly, but the government didn’t even keep data on M1 and M2 until fairly recently. No one in the 1920s thought the Fed should be targeting aggregates that didn’t even exist.”

Of course not, but that’s not the point at issue. The point is that a rapid expansion in broad money may have been a contributing factor. Whether it was measured at the time, or whether anyone thought the Fed should be targeting it at the time is irrelevant.

“it is a response to the claim that the 1929 crash was caused by a preceding inflationary bubble. I will show that the 1920s were not inflationary, and hence that there was no bubble that could have caused an economic slump which began in late 1929…. 5. The price of gold”

Can you indicate one Austrian economist who has claimed an increase in the price of gold was a cause of the economic slump?

“I wish the term ‘inflation’ was used for rising NGDP, not rising prices. And of course Hayek favored a stable NGDP. If that’s what they mean by ‘inflation,’ then they can claim a meager victory for the 1920s, but very meager.”

Of course the plain fact is that they are two completely different concepts. So of course, Hayek didn’t mean NGDP when he said inflation. Hayek meant an increase in broad credit. If you think he used the wrong word to indicate an increase in broad credit, that doesn’t affect his argument. It’s what he meant that counts, not your personal interpretation of the written words in the context of your world view.

If NGDP per capita was falling during the 20s, but there was strong economic growth, and you believe that growth could have been maintained through monetary policy, and was therefore sustainable, how can you continue to claim that a 5% NGDP target is desirable? Why don’t we aim for a stable decrease in NGDP per capita instead, so we can emulate the roaring 20s? (Not that I think that would work either, but it seems logically consistent with your reasoning process).

“And by the way, interest rates were not particularly low during the 1920s, particularly when you consider that it was a period of deflation. So no one can seriously claim the Fed was following a low interest rate policy.”

Broad private credit was low after WWI. With the return of normal economic activity, and due to the low base, broad credit grew rapidly. The Fed could have limited the growth of broad credit, either through higher interest rates or other means. Whether they were or were not following a “low interest rate” policy is not relevant, because “low” is a relative term, and interest rates are not the only means by which broad credit growth can be restricted. Whether you call the increase in broad credit “inflation” or not makes no difference.

Similarly, the Fed could have prevented the huge run up in broad credit that we have seen over the past 30 years, which leaves us in a much more dire situation than prior to the great depression. The reason they did not is because they have no incentive to do so – the cycle has been so long that the guilty are well out by the time the piper has to be paid.

Please find citations showing that Mises or Hayek were focused on “broad credit.” If increases in credit were financed other than by an increase in bank monetary liabilities, I am quite certain that Mises nor Hayek would not consider it a problem.

I think you are confusing the Austrian Business Cycle theory with some version of the real bills doctrine or “creditism” more broadly.

Imagining that banks solely issue checking accounts and the “money multiplier” story of lending, deposits, lending, and so on, is the source of all or even most credit, is not a realistic account of the twenties, much less today.

Scott:

If the Fed lowered its target for the interest rate at all, this would count as “inflation.”

Mises, especially, was focused on conscious efforts to use monetary policy to lower interest rates. The thought experiment of trying to abolish interest income by an expansionary monetary policy is always the baseline. And any time a monetary authority lowers interest rates, it is kind of the same thing and so will have similar consequences to that quiotic policy.

All of this supposed “devaluation” business described in other comments isn’t devaluation of course. It would be an intentional reduction in U.S. gold reserves and in particular, a lower gold reserve ratio. The association of these actions with a lower policy interest rate would “mean” that the interest rate is below the natural rate. Strong’s policy of allowing the rest of the world to get back some of the gold reserves they had lost in WWI to resume the gold standard was “the problem.” And if a lower policy rate is ever used, then that “clearly” is using monetary policy to lower the market rate below the natural rate. (These aren’t quotes from any austrian’s but rather emphasis.)

Hayek would argue that Wicksell’s approach with the price level was mistaken. If real GDP were constant, that would do. But it is nominal GDP (the flow of spending on output) that is causing the problem. And so, when real GDP is increasing, a market rate equal to the natural rate keeps nominal GDP constant and results in price deflation.

I think that is his view, and I don’t agree with it. Or Wicksell either. If you start with a regime of constant nominal GDP, and that is what is expected, then Hayek is right. If you start with a regime of stable prices, and that is what is expected, then Wicksell is right (if real GDP grows at trend–supply shocks mess it up.) If you start with a regime of 5% nominal GDP growth and that is what is expected, then there would be 2% price inflation on average when the market rate is equal to the natural rate.

It isn’t clear to me that most Austrians have even yet figured this out.

Most of Hayek’s analysis was based upon a given velocity. He was always skeptical about the practicalities of using monetary policy to offset changes in velocity. But eventually he saw that the huge decrease in base velocity in the early thirties needed to be offset. Imagining that it could be done perfectly always is a pipedream. But when it drops by 50%, getting it off by 1 percent or 2% doesn’t look so bad. You know, the Fed could not have used monetary policy to keep nominal GDP at the 1929 level in 1933. And having NGDP in 1933 2% above the 1929 level would be a bad thing. Probably as bad as having it 2% below the 1929 level. But those concerns became smaller as he realized that either of those is much better than having it at 50% below the 1929 level.

There’s another terminology discrepancy here. Mises referred to all paper money as “money substitutes,” and every – at least, I *think* every – increase in the quantity of “money substitutes” was termed a “credit expansion.”

Banks can expand the volume of money substitutes. Counterfeiters can expand the volume of money substitutes. Central banks can expand the volume of money substitutes. No one else can.

Now, I’m no Great Depression expert and I haven’t read Rothbard’s take on things. I tend to stick to Mises, because his arguments make the most sense to me. My thoughts are simply this: I consider Mises’ take on credit expansion as the source of boom-and-bust to be a perfectly accurate theoretical description. *IF* Rothbard is correct to suggest there was a credit expansion in the 20s, *THEN* I think the Great Depression is fully consistent with the Misesian view. I leave it to others to demonstrate the credit expansion or lack thereof. My initial comment was simply to make you aware of the fact that Austrian School economists have developed their own measurement of “the money supply,” so I would imagine that if we see a credit expansion in the 1920s data, we’ll see it there.

“I’ve shown there was no inflation as the term was defined at the time. I’ve shown that there was no alternative non-inflationary policy as understood by policymakers at the time, including those in the 1920s who claimed the Fed was too inflationary. It makes no sense to argue things were inflationary because M2 went up, if M2 didn’t exist. There are no policy implications. M2 was an idea invented much later.”

Scott:

My apologies for the long comment, but I am trying to clarify what I think you said and why I think that does not refute the Austrian view.

In your opening you state that you set out to refute the Austrian view that the crash was caused by an inflationary bubble. Your argument is that there was no inflationary bubble so an inflationary bubble could not have been the cause of the crash.

At #2 you define money inflation based on the data available at the time. You then proceed to argue that the data you found did not show an increase. You then continue that even if other aggregates not in existence at the time would have shown an increase, that this would not make the Fed culpable because they could not have known. You conclude then because the Fed is not culpable that there was no money inflation and that the definition used under #2 therefore does not show that there was an inflation.

That the Fed is not culpable however does not refute that inflation – defined as an increase in the ‘money supply’ – occurred. I agree with you in so far that there were no policy implications for the Fed, I disagree however that you’ve refuted the Austrian view.

To simplify, your argument and in particular this:

“I’ve shown there was no inflation as the term was defined at the time. I’ve shown that there was no alternative non-inflationary policy (…)”

Reads -in conjunction with your opening statement and #2- to me as, “because ‘doctors’ in Europe during the black death could not have known what caused the black death, there was no black death.”

“The entire monetary expansion took place in money-substitutes, which are products of credit expansion. Only a negligible amount of this expansion resulted from purchases of government securities: the vast bulk represented private loans and investments. (An “investment” in a corporate security is, economically, just as much a loan to business as the more short-term credits labeled “loans” in bank statements.)” (Rothbard 1963)

“in the misdirection of labor and the distortion of the structure during the past business cycles, it was fairly easy to point to the excessive expansion because it was, on the whole, confined to capital-goods industries. The whole thing was due to an over expansion of credit for investment purposes,
so you could point to the industries producing capital equipment
as those which had been over expanded.” (Hayek 1975)

“The crisis from which we are now suffering is also the outcome
of a credit expansion.” (Mises 1931)

What Rothbard was saying is that the Fed and banks mostly made loans to the private sector rather than to the government.

This is not the same thing as saying that most of the loans to the private sector came from banks or the Fed or that the banks funded most of their loans with monetary liabilities.

There is direct finance through bonds as well as nonbank intermediaries like finance companies.

Further, banks don’t fund all of their loans by creating monetary liabilities.

As for Hayek, why was the source of the “over expansion” of credit? Was it that households purchased too many corporate bonds?

And with Mises, what was teh source of the credit expansion? Was it that business chose to purchase bonds issued by other firms rather than internally invest? Was it that people put money into savings banks and the savings banks made commercial loans?

Read more carefully. Mises is all focused on “fiduciary media,” which are monetary liabilities used to fund credit. That isn’t the sole source of credit.

“This is not the same thing as saying that most of the loans to the private sector came from banks or the Fed or that the banks funded most of their loans with monetary liabilities.”

I didn’t claim they said most of the loans came from banks.

“Further, banks don’t fund all of their loans by creating monetary liabilities.”

I didn’t claim this either.

“As for Hayek, why was the source of the “over expansion” of credit? Was it that households purchased too many corporate bonds?”

So you agree that Hayek did focus on broad credit? The composition of the credit is irrelevant to the claim you made that he did not. Credit emanated from the explosion in the number of non-bank financial institutions, and the rapid liberalization of the financial markets. This manifested in a rapid rise in installment credit, stock purchases on margin, a tripling in mortgage debt and so on.

“And with Mises, what was teh source of the credit expansion? Was it that business chose to purchase bonds issued by other firms rather than internally invest? Was it that people put money into savings banks and the savings banks made commercial loans?”

Again, this is not relevant to your claim that he did not focus on broad credit. There was a rapid growth in non-bank lending.

As opposed to the pseudo-scientific, Marxist idea that capitalism is inherently unstable and will lead inevitably to mass unemployment and strife, there is a general agreement among macroeconomists today that the Great Depression was the product of the…

Jon, Sorry if I sounded pissed off. I’m trying to confine the discussion to the question of whether the 1920s were an inflationary decade. I’m not seeing evidence that it was.

Bonnie, At this point I think it’s more realistic to fix the Fed, but in the long run I’d like to see the market determine the money supply and interest rates.

Greg, I’m not sure who your comment is aimed at–I’m just trying to figure out whether the 1920s were inflationary. Is that too much to ask?

Lorenzo, Well put.

Paul, Debts weren’t particularly high in 1929.

Doc Merlin, No, manufactured goods prices were not high. Output was respectable, but nothing out of the ordinary.

Paul, You said;

“Can you indicate one Austrian economist who has claimed an increase in the price of gold was a cause of the economic slump?”

I said that this post is not aimed at Austrian economists, it is aimed at Austrian commenters. That claim was made in this very comment thread.

I find it hard to believe that inflation is being defined as an increase in private sector credit, although I suppose anything is possible. Most people define it as an increase in either the money supply (Fed policy) or prices. Someone told me that von Mises defined it as an increase in the money supply, which was the base back in those days. But I can’t be sure.

But if it is credit, one certainly can’t blame the Fed, as the Austrian economists of the 1920s weren’t suggesting they target monetary aggregates. And yet the commenters who come over here to blame the Depression on an inflationary boom in the 1920s, seem to think it was the Fed’s fault. But they don’t control credit, they control the base. What was the Fed supposed to do? After all, the base didn’t increase.

Regarding 5% NGDP targeting, I discussed that above.

I agree with Bill Woolsey. I find it hard to believe that Hayek would get upset if I loaned my neighbor $5, or even $5,000,000,000.

And finally, if the increase in credit led to a depression, why weren’t the 1940s, 1950, 1960s and 1970s followed by depressions?

Bill, I don’t think the gold ratio would work either. The base was roughly constant, and I am pretty sure that the gold stock rose during the 1920s, although I don’t have the data in front of me.

Ryan, Ok, But I’m still waiting to see Austrian money supply data from the 1920s, which was published in the 1920s. In other words, the monetary data Mises was looking at.

Martin, Fair point, I should have pointed out that the commenters weren’t just claiming the 1920s were inflationary, they were blaming the Fed. This view is supposed to be based on stuff that was published during the 1920s by Austrian writers. Again, I’m no expert here, but I’m pretty sure the Austrian story is not that M2 went up to fast. But maybe it is. I await enlightenment.

If Paul is right, then why are so many of my Austrian commenters obsessed with the Fed? If it’s credit, then the Fed plays no role in these bubbles.

“But if it is credit, one certainly can’t blame the Fed, as the Austrian economists of the 1920s weren’t suggesting they target monetary aggregates. And yet the commenters who come over here to blame the Depression on an inflationary boom in the 1920s, seem to think it was the Fed’s fault. But they don’t control credit, they control the base. What was the Fed supposed to do? After all, the base didn’t increase.”

Are you perhaps thinking of banking aggregates and ignoring the balance sheets of other financial intermediaries? There was even a mortgage securitization boom in the 1920s not dissimilar to the recent securitization boom: http://www.nber.org/papers/w15650

All that’s true, but who said Internet Austrians cared about the facts?

Murray Rothbard’s “Austrian” explanation of the Depression is is merely so much pseudo-economic claptrap designed to rationalize a conspiracy theory of history in which a few dozen bankers are responsible for everything that’s wrong with the world. Internet Austrianism is social credit for libertarians, and Rothbard merely the most successful pseudo-economic cult leader since Major Douglas.

In case you didn’t wade through that trackback: Making 1919 your NGDP baseline is misleading. The 1919-20 inflationary spike was just a quickly corrected mini-cycle on top of a major upward shift in NGDP started in 1915 and running up until the 1929 crash, consistent with the Austrian account of the boom and initial bust — and independent of what drove the subsequent, lingering slump. I show the whole graph (and elaborate on this) here:

Scott,
With regards to your comment about a natural level of NGDP, you’re fundamentally right, but perhaps there was an issue with my terminology. What you said is what matters is the target. Indeed, in your framework you can’t identify whether monetary policy is easy or tight without the target.

I suppose what I was thinking was 1) what was the Fed’s rule like in the 1920s and 2) given this effective rule, what periods of the 1920s would be categorized as easy or tight. The second part is really what I am interested in, but it requires the first part.

So really, I want to figure out what kind of rule the Fed was following in the 1920s. As an experiment, I tried to figure out the monetary base rule the Fed seemed to be following in the 1920s (tried the discount rate, but they really weren’t targeting that). I figured that I couldn’t put it in NGDP terms, but I can at least compare that to period that you consider closer to following an NGDP target and see if it passes the smell test.

So I regressed log changes in the St. Louis Monetary Base against a detrended (based on the whole history) YoY growth in IP and YoY growth in inflation from 1920 through just before October 1929. Both coefficients are modestly positive and statistically significant. The IP coefficient was modestly smaller than the inflation coefficient. In other words, the Fed allowed an increase in the monetary base when IP grew faster than trend and when inflation grew strongly over this period (the Fed stopped following this rule in late 1930 or so when the monetary base was allowed to expand).

By comparison, over the Great Moderation (1982 to 2005 or so, for the sake of simplicity), the Fed basically targeting a constant growth of monetary base and leaned against detrended IP changes (low R^2 since there were some shocks to monetary base around 2000 and 9/11 that I didn’t bother to correct for). By contrast from 2002 or so to mid-2008, both detrended IP and inflation were statistically significant in explaining money growth (both negative coefficients).

Since the Great Moderation period is closer to what it would be like to follow an NGDP rule, I think you could safely say that the rule from the 1920s is not consistent with an NGDP rule. What the Fed has done recently is to lean against elevated inflation or IP growth being above trend. In the 1920s, the Fed effectively allowed the monetary base to do the opposite.

Hence, I would argue that it would be stretch to claim that the central bank was following an NGDP rule. The Fed allowed money growth to modestly accelerate when times were good and inflation was rising. That would likely not be consistent with what you consider good monetary policy and those periods were likely too easy (as the Austrians claim), but I cannot prove it given the data available.

Bob, Look at section 6. I had the 1926-29 rate in there from the beginning. People must be just skimming the post.

John, If you read the statements of Gov. Strong, he said he was trying to lean against the wind, stabilize prices and reduce output fluctuations. That’s not exactly NGDP targeting, but it’s in the spirit. But I never claimed they were following an NGDP rule, I said it was fairly stable (not precisely stable.)

It’s very hard to know anything about monetary policy via regressions. There are identification problems on steroids.

Scott, you don’t need to respond, but FYI what I was saying is that you didn’t deal with the monetary base except from its near-peak in 1920 to the end in 1929. Yes, in section 6 you focus on 1926-1929, but only to say that NGDP growth was terribly fast. OK, but no Austrian means “NGDP growth” by “inflation.”

I’m not saying you were cherry-picking numbers; you obviously picked the start and end of “the 1920s.” But this is definitely a point I will make in my devastating reply, coming soon to an intertube near you.

I agree there are huge problems with my analysis (enough to drive a truck through, perhaps). However, it’s one thing to use vintage data to figure out what the central bank’s decision was ex-ante (which is incredibly tricky) and another to try to perform an ex-post evaluation of what the central bank was doing assuming it had the data we have. I’m not trying to use the data to predict what the Fed would have done. I’m just trying to understand what they were doing.

The regressions suggest that the Fed allowed the money base to respond to IP shocks and inflation shocks in a manner different from today.

John Hall, That’s a fair point. But I was under the impression that Austrian macro had a long intellectual tradition, with strong views on the 1920s which were formed during the 1920s. I’m trying to understand what those views were. It’s fine if modern Austrianism is different because they have better data, but if so they need to make that point more clearly.

Scott, Trying to divine the exact thought process of Mises et al. in the 1920’s is an interesting historical project, but it’s a secondary point, and you have not addressed the more important fact that their basic view was demonstrably right according to your very own (correct) NGDP-based assessment — as long as you look at the whole NGDP time series over the period and not just take the short-lived inflationary spike in 1920 as your baseline. Again, I show this time series and make a fuller argument here:

According to John Hicks, it was Hayek who got Keynes & Hicks to move away from thinking in terms of price levels and interest rates:

“Hayek was making us think of the productive process as a process in time, inputs coming before outputs ..”. (John Hicks, Classics and Moderns, New York: Basil Blackwell, 1983, p. 359).

J. Hicks, “It is not so well known that it [Keynes’s and my own move from thinking in terms of price-levels and the rate of interest to thinking in terms of inputs and outputs] is matched by a movement from Hayek to Harrod. I once asked Harrod what had put him on to the construction of his so-call ‘dynamic’ theory; he said, to my surprise, that it was thinking about Hayek.” (J. Hicks, 1982, pp. 340-341)

Hayek’s radically non-Marshallian way of approaching monetary theory in relation to equilibrium constructs/long period Econ played a role in Keynes’ re-thinking of the task of monetary theory:

“I am in full agreement, also, with Dr. Hayek’s rebuttal of John Stuart Mill’s well-known dictum that ‘there cannot, in short, be intrinsically a more insignificant thing, in the economy of society, than money,’ [when Hayek writes]: “it means also that the task of monetary theory is a much wider one than is commonly assumed; that its task is nothing less than to cover a second time the whole field which is treated by pure theory under the assumption of barter, and to investigate what changes in the conclusions of pure theory are made necessary by the introduction of indirect exchange. The first step towards a solution of this problem is to release monetary theory from the bonds which a too narrow conception of its task has created.'” (John Maynard Keynes, “The Pure Theory of Money: A Reply to Dr. Hayek”, Economica, Nov. 1931, pp. 395-396.)

A. Cottrell, “Keynes was shortly to develop his own approach to the general task identified by Hayek [i.e. the task of monetary theory], under the rubric of `A Monetary Theory of Production’ (Keynes, 1973, pp. 381, et seq.).” (A. Cottrell, 1994, p. 199)

Declaring that you know little about something and then claiming to refute it is just plain silly. Go read Mises, Rothbard and other scholars in the Austrian tradition who have written about the 1920s and 1930s – and THEN come back and tell us where they went wrong. They’re obviously looking at different data than you, over different time periods, or they’re interpreting the data differently.

Coming up with arguments based on nothing but a shallow reading of “internet Austrianism” (i.e. blog comments by anonymous non-academics) isn’t going to convince anyone that you’re right and Austrian economists are wrong.

Again and again I find that when I read Austrian economists, they attempt to refute the arguments of non-Austrians by closely reading and analyzing the non-Austrians’ scholarship, and then bringing forward their opponents’ arguments fairly and with many detailed references and footnotes. But whenever I read a non-Austrian economist attempting to refute Austrianism, the arguments are of the straw-man variety. Apparently the anti-Austrians such as Krugman (and others) have never read any of the scholarly works that they claim to disagree with – they never mention specific writings, they never quote specific passages, and they usually never even give the name of a single Austrian scholar. A commenter above jokes that “Saint Rothbard” has been attacked … but has he? His name is not even mentioned in the article, nor is Mises, nor any other Austrian, nor are any of their works cited. Some scholarship!

Well, I have to say the first thing that came to mind upon reading this post was that it is silly. Because M2 wasn’t calculated during the 20s, there was no inflation? (If a tree falls in the forest and no one is there to hear it, does it make a sound?) If we call a rising money supply inflation, what a disaster, there will be no term for rising prices? The inflation rate for gold was 0%? Simply amazing. I’m most glad that I don’t have to suffer through this guy’s classes.

[…] the present article, I want to respond to a recent post “” titled “The myth at the heart of internet Austrianism” “” in which Sumner criticized the Austrian explanation of the Great Depression. I will pick apart […]

[…] the present article, I want to respond to a recent post “” titled “The myth at the heart of internet Austrianism” “” in which Sumner criticized the Austrian explanation of the Great Depression. I will pick apart […]

Eric, Was NGDP growth in the 1920s rapid or not? I say it was one of the slowest of any decade in modern American history. And it’s not all based on the 1920 starting point. I also showed in my post that NGDP growth was quite slow in the three years leading up to the Great Depression. If that’s an inflation bubble, then virtually all of American history is one giant inflation bubble–in which case the theory explains precisely nothing.

Greg, Thanks for that quotation.

Marco, You said;

“Instead of a 69 million increase in the base between 1920 and 1929 we have an approximate BILLION increase from US$5.5 billion to 6.5.”

I don’t agree. I got my monetary base data from Friedman and Schwartz’s Monetary History of the US, which is widely regarded as the best scholarship on the Depression.

Hamish, You said:

“Declaring that you know little about something and then claiming to refute it is just plain silly. Go read Mises, Rothbard and other scholars in the Austrian tradition who have written about the 1920s and 1930s – and THEN come back and tell us where they went wrong. They’re obviously looking at different data than you, over different time periods, or they’re interpreting the data differently.”

Hamish, You don’t seem to understand how blogging works. I don’t take orders from commenters, you respond to my requests. I challenged internet Austrians to explain to me why the 1920s was “inflationary.” So far no one has been able to find a single flaw in my data. As far as I’m concerned it’s case closed. The internet Austrians talk about an inflationary 1920s, but don’t have a clue as to what they are talking about. The 1920s were DEFLATIONARY.
If you don’t agree, tell me what’s wrong with my argument, don’t tell me to read books that I have no intention of reading (because life’s way too short.)

Craig, So let’s say at the end of an great empire the money supply stays unchanged but the price of goods rises a million percent (because the collapsing empire means people expect the money to be worthless.) I take it from your comment that there is no “inflation” because prices didn’t rise.

But it’s a moot point, because the money supply didn’t rise either.

Pierre, Bob didn’t find a flaw in any of my arguments, and in fact weakened his own position further.

He agreed with me that the 1920s were deflationary, but then claimed that this shows deflation can occur during prosperity. But I agree! I agree the 1920s were deflationary, and I agree the 1920s were prosperous. As far as I’m concerned, he proved my point.

He also alluded to the fact that stock prices soared despite the fact that gold prices were stable. So what? Was the period from 1966 to 1982 deflationary just because the DJIA fell? Is that Bob’s argument? Is he arguing that the 1970s were deflationary? Obviously not. So why should we care that stock prices rose in the 1920s? They have nothing to do with the question of whether it was a deflationary decade.

Then he starts cherry picking data, showing there were sub-periods during the 1920s when the monetary base rose. But so what? The base was pretty flat during the entire decade, and it was pretty flat during the last 5 years of the decade. Sure you can cherry pick years 2 through 5 when it rose, but how does that relate to the Great Depression? And population growth was rapid, so even that small increase was much less in per capita terms. Indeed the monetary base per capita fell by about 15% during the 1920s–is that “inflationary?” If so, then virtually all of American history is one gigantic inflationary bubble, as the base has trended upward during the vast majority of years. But a theory that says almost every year is an inflationary bubble would have virtually no predictive power. We should have Great Depressions every few years, because the base usually increases much faster than it did during the 1920s. So yes, you can cherry pick a few years in the early 1920s when the base increased, but that’s an incredibly weak argument for the crash of late 1929.

Then he starts talking about things like the rise in life insurance policies. What does that have to do with inflation? I’m sure stamp collections also increased in size during the 1920s.

Suppose Austrians had their dream economy, with a free market gold standard. No government. The private sector could still increase the size of the insurance industry, it has nothing to do with monetary policy. You don’t need more money to boost the size of the insurance industry–companies can just write out policies. Indeed that’s true of credit in general. My brother an I can loan each other a trillion dollars, by making marks on a piece of paper. That’s not money and that’s not inflation. It’s credit.

Then he talks about the 1927 open market purchases. But what does that have to do with my argument. I never denied there were OMOs, I said there was no inflationary bubble. His own chart shows the OMPs had almost no impact on the money supply. Is he saying OMPs are inflationary even if the money supply doesn’t rise?

Bob knows that my data is accurate, so he seems to be reaching for other justifications for the “inflationary 1920s” argument, but there just aren’t any that I can see. It was a DEFLATIONARY decade. Period, end of story.

Rob, M2 is a human construct, not something out there in nature. Obviously you can go back and construct it in retrospect, but it doesn’t help to support the argument made by Austrian economists during the 1920s, as their argument that the Fed was too easy was obviously not based on the notion that the Fed let M2 rise too rapidly. I thought Austrians didn’t want a central planning Fed, trying to control private sector aggregates like M2. So in what way was Fed policy “inflationary?”

Lvm, Yes, I am so sorry I spread all that disinformation about Austrian economics in my post. I now admit that all the data I provided in this post is false. I just made up the numbers. Please accept my deepest apologies. I promise to never again say anything bad about Austrian economics.

Scott, If you look at the graph I linked, two things are clear. There was an abrupt shift around 1915 to a much higher NGDP growth trend. As you know, the decisive factor for shaping expectations in the short/medium-run is deviation from trend. The quite substantial difference between the pre- and post-1915 trends implies serious monetary disequilibrium and, from an Austrian perspective, distorted capital markets not in line with actual inter-temporal consumption preferences.

The second thing that’s clear is the 1919-1921 mini-cycle starting with an inflationary spike and switching to a deflationary one. This was the context for the resumption of the above-normal NGDP growth trend through the rest of the 1920’s. The deflationary dip in 1921 must have set up expectations that could only amplify the inflationary nature of the subsequent NGDP surge.

Now maybe you can argue about the duration of inflationary disequilibrium through the 1920’s (perhaps demanding a more quantitative analysis similar to that of my white paper), but the overall picture presented by the NGDP time series over this period is pretty clear.

The only intelligent basis for claiming price inflation or deflation is the price of a basket of commodities. I think they were kind of flat in the 1920’s and decreased afterwards. MONEY deflation occurs when debts are paid, or there are changes in reserve banking. In the 1930’s people withdrew from banks (in addition to direct collapse) so that M2 collapsed. M2 is what Austrians are interested in, not the base.

Jim Rogers is Austrian. He says trade wars were terrible during the depression, indicating he thinks they were a cause. Peter Schiff and Jim Rogers say government intervention made the depression linger. Ron Paul thinks M2 increased in the 1920’s (it did not).

Wikipedia says Austrian’s think it was lack of money after the crash that caused it to be a great depression. The wiki article says the Keynesian explanation is underconsumption. The modern view of a keynesian fix for this seems to be to print more money, so I can’t see where the Keynesians are different than Austrians in the key problem. The only difference is that they both blame government in opposite directions: government should have stayed out of it (Austrian view), or that government should have intervened more (keynesian).

My view is that we always need more smart government and less dumb government. Government is supposed to be enforcer of the average person’s desire via votes. This is the feedback mechanism that is required in order for the marketplace to be Turing Complete. The free market by itself (even with extensive rule of law for fairness in each individual transaction, adjustments for externalities, and anti-monopoly statutes) is an algorithm that seeks optimal efficiency without regard to the size of GDP or average human happiness. Even if the prisoner’s dilemma in each transaction is locally “win-win”. One person having all the world’s wealth and zero GDP is a valid solution to the free market algorithm. Near-zero GDP is the preferred solution of the efficiency algorithm because resources will be more readily available and therefore at lower cost to produce, and diminishing the human population offers the possibility of keeping only top-notch workers available. You can have even a surplus of workers for lower cost if GDP is lowered even faster than the population. You also don’t have to make new machines if GDP is in contraction. This is the core error in Austrian economics. The purpose of voting is to provide feedback to the free market in order to increase system-wide total profit (real GDP, not the financial sector). Democracy prevents wealth from accumulating into luxury spending and thereby helps keep commodity prices low (the masses buy what they need). With more commodities and a healthier and more intelligent populace, the country can then overpower other countries who did not follow an equally effective plan. That’s why truly free markets have not evolved to be the most powerful and populated.

The preferred method these days of the free market for reducing the need for labor and resources is to financialize the GDP. This concentrates wealth, but that is not the goal. The goal is to lower industrial and commodity-driven GDP (costs) in terms of the currency. Money printing therefore benefits the goals of a free market, even though proponents denounce it. Another option is to find cheap labor without regard to the long-term effects on the currency as a result of shifting production overseas. The free market is a great local calculation that has short-term positive effects system-wide (the invisible hand) but has no emergent intelligence that seeks a higher GDP or happiness for the long term. Short-term solutions without intelligent regard for the long term may be a good summary for the free market. It seeks minimum energy levels.

Eric, I agree that WWI pushed prices and NGDP much higher all around the world. What I don’t agree with is the idea that the 1920s were inflationary. Even if you start the clock later in the decade (not in 1920) the trend rate of NGDP growth was about 3%. That’s way lower than during almost all of the past 100 years. So the 1926-29 cycle was one of the least inflationary in all of modern American histroy. Certainly it didn’t cause the collapse of 1929, or else we’d have much worse collapses all the time.

It’s interesting to me that Austrains don’t seem to agree as to what “inflation” is. Some say grwoth in the money supply, others say growth in credit, others say growth in NGDP.

I agree with zawy, price inflation is the most sensible definition, it’s what everyone means in the real world. Certainly the growth in NGDP was not caused by expansionary Fed policy, by most definitions (interest rates, money supply, gold ratios, etc.)

I think the most reputable Austrians say money supply is inflation, and M2 was previously the best available.

I didn’t say price inflation is the best measure of real inflation, but specifically commodities, when determining if we are creating too much money or not. Prices of other goods and services can contain too much “non economic” costs such as interest, fees, and insurance (the FIRE sector which financializes capital away from real production, into the hands of non-producers to create more non-producers). Inflation that results from these costs can’t be fixed by monetary policy. It needs to be corrected by legislation to get rid of these “new-age Rentiers”. So as a consumer, yes, price inflation is inflation: whatever it costs to maintain my lifestyle. This gets complicated if I want to keep up with “society and the Jones’s” like the CPI attempts. But for the discussion here, inflation should be price of commodities, if we are focusing on what the Fed should do, or should have done. For example, the CPI has averaged 2.3% for 10 years, but in terms of commodities inflation has been about 13% per year for 10 years (based Rogers index 11% APR return which is an underestimate because it rolls monthly futures contracts instead of following spot prices…8% underestimate per year in agriculture, 0.75% in metals). So the Fed should have been tightening the past 10 years. This would have prevented the housing bubble and therefore a lot of the financialization. Higher interest rates would have slowed the economy down so that fewer commodities would have been used (a lot of it in China) to supply us with “stuff”, food, and energy. If commodity prices start increasing, it’s best to nip it in the bud. I think stopping commodity swings may go a long way to prevent bubbles. Buffett’s hero Benjamin Graham wrote 2 books on it in 1937 and 1944, with support from Hayak and Keynes as a way to prevent deep depressions. So there’s another point where there should be consensus on the depression. Printing money like they Austrians and Keynesians wanted for the 1930’s would have brought stability to the price of commodities which fell in 1929 and didn’t recover until 1936.

Financialization causes near term price inflation and is murder on long term commodity inflation. Murder in the sense that it has been theorized that financialization is the last stage of an empire (like Spanish, Dutch, and England). Michael Hudson says the end comes when balance of payments gets out of whack to finance a final war (trade deficit, capital flight, and military spending causes capital to come back as loans…sounds frighteningly familiar). The fall of the dollar in terms of commodities is coinciding with the fall of the country.

See Michael Hudson’s early 1970’s books that saw it all coming (He’s not an Austrian, Keynesian, or Marxist…he’s an anti-neoliberal). He has an extensive blog.

Scott, What’s important is the deviation from NGDP growth trend, not some absolute level of growth — and deviation from prior trend, not trends that occurred decades later. Looking at 1926-29 in isolation doesn’t tell you much, when the two relevant trend shifts occurred in 1915 and 1921. The time series shows clearly that inflationary disequilibrium, hence capital market distortions, must have occurred sometime after 1921. The argument is not about what triggered 1929, it’s about whether such distortions were building up over the 1920’s or not.

It’s true there’s a schism among Austrians about defining inflation. The Hayekian free banking camp essentially agrees with you about some kind of NGDP trend criterion for loose/tight money, and that’s the framework in which I’m arguing for looseness in the 1920’s. What “internet Austrianism” really refers to is the Rothbardians. But if you want to honestly attack the Austrian school, you’ll have to take on its strongest version, not just its weakest.

I agree, commodity prices tell you what is going to happen in the future, not what is happening now. There may be a place for short term NGDP targeting, but I believe it has the potential of increasing or decreasing the negative effects of financialization, so its application should not be blind. For example, it may sweep financial misallocations under the rug for short term benefit (especially for the benefit of the rentiers) at the expense of the long term (real) economy. CPI and GDP conflate finacialization (40% of U.S. GDP is non-productive financialization), so any policy based on them is not targeting the real economy. Maybe NGDP could be redefined to be based on a real GDP.

Commodity price targeting may have completely prevented 2008. Since we did not apply commodity pricing then, we may need to apply NGDP targets. With a history of our industry leaving and a balance of payments gap, we may need to devalue the currency in order to regain competitiveness by lowering our living standards to that of Asia, as Asian standards rise. This is the result of free trade that does not let labor trade as freely as goods and intellectual property. The free market seeks an equalization of wealth across borders, and an unequal distribution across class. It’s more efficient to have wealth concentrated based on investment skill and not location.

Conversely, in the 1920’s I think commodities were flat, so commodity targeting may have helped only after the fact, preventing the depression from getting worse. NGDP targeting may have prevented the crash altogether.

Commodities are the inputs to everything that happens in society. All economic prices are the result of a long history of commodities up until the present. Asset prices that are not the result of commodity and production are the result of human psychology, manipulations, and power struggles.

NGDP targeting negates the impact of sticky wages and sticky prices, so it looks only at the “now”. Commodity targeting looks partially at the now, but has more of a predictive nature. For example, if commodities get too cheap, company profits may surge, setting the stage for a bubble and burst. Commodity targeting keeps price signals pure, which Austrians should love, and I prefer. Sticky wages and prices are a real phenomena, so NGDP may have its place. But I think it needs to be based on a real GDP.

Commodity prices are subject to a global market, but the U.S. has to pay those prices before anything gets done.

Regardless, monetary policy by itself does not prevent financialization from forcing bankruptcy and all our industry into other countries. As the FT discussed this week, Greece has a trade deficit crisis, not a debt or deficit crisis because both of these measures were better for Greece than France, Germany, and the U.S. prior to 2008.

Eric, Why not say the NGDP trend was fairly level during the 1920s, and the policy mistake was allowing a huge (50%) drop in NGDP after 1929. Then the Depression would have been caused by tight money in the early 1930s, not easy money in the 1920s. I.e. Friedman and Scharwtz, not Hayek would have been right. Since Hayek later (in the 1970s) admitted he was wrong, I think that’s the most sensible interpretation.

I don’t follow your argument about trends, The post WWII trend was radically higher than pre-WWII an rising fast. Far more expansionary that the 1920s. Yet until the late 1990s tech boom there weren’t any obvious major misallocations of capital–the economy did pretty well in real terms.

I don’t disagree with Ron Paul’s perspective. He was thinking the depression would occur in the 1990’s. He underestimated how strongly the world was married to the dollar, and how far we would allow ourselves to get into debt. This will end by 2020. China will soon be doing the majority of trade in bilateral currency agreements (currently Russia, Brazil, Malaysia, and several others). His comments back then could have lead to terrible investment advice for 1988 in regards to stocks verses gold up until 2000, but the gold he and other Austrians bought in the early 1970’s has so far done 5 times better than the DOW. That’s 5 times over the very long haul based on ideas he has not changed in 40 years. So I would not disregard the accuracy of the Austrian view of the big picture.

By wanting to somehow do futures for “real” GDP and let the Fed peg that, I’m wanting to encourage contraction for the financial sector and allow real GDP wages and prices to be sticky. But on second thought I do not think simple whole-market liquidity can throw out the bath water without throwing out the baby. At best this would just be a half way measure between a commodity peg and trying to prevent a deflationary spiral.

Let me back up and explain the problem I see in your idea. GDP can increasingly become financialized and this “fake” GDP is harmful in the long run. A liquidity peg to the market’s NGDP expectation will include support of these financial effects. If you increase liquidity even as our real GDP (manufacturing sector, etc) is flailing, it can end up going only towards more ASSET price increases (against which financial sector gives loans or directly speculates without producing anything we need) and to the purchase of foreign goods and services, rather than to stimulate local USEFUL employment and manufacturing. This is what has been happening with QE, as has been documented. This might be the primary goal of QE: to keep houses inflated so that the government does not collapse from a big fall in the 90% of all mortgages that it now backs. We have 3 or 4 times more sq ft per person as we did in 1970, contributing to urban sprawl and making public transportation even less of an option, decreasing our ability to keep wages (and therefore goods and services) low to remain competitive. Your idea seems to be to keep injecting money until asset prices have risen beyond belief, until the non-productive financial aspects of the economy are stuffed full. Only after that has occurred would beneficial employment and manufacturing occur. It would keep home construction going (an example of ASSET price inflation) even though we need those workers to produce things we need.

Likewise in your writings I see references to the CPI which is about 1/3 financialization, showing that you seem to not be taking asset prices into accuont. Or rather, you’re allowing them to be conflated with the real economy. Instead of adjusting for sticky wages and prices in goods and services to prevent a deflationary spiral (liquidity trap) in the real economy, you’re also keeping asset prices inflated, not letting a terrible bubble burst, keeping people employed in the financial sector and useless construction that uses up commodities and labor that needs to be used elsewhere.

Economics is subject to the laws of physics, specifically and pervasively to the conservation of energy (“you don’t get something for nothing”). Providing meaningless jobs does not enable us to more effectively tap energy to move matter (economizing) for a better standard of living (politics). Any economics that does not begin and end with tracking the beneficial utilization of energy is doomed. The last American I know to do this in terms of physics is E Peshine Smith who was instrumental to the rise of Meiji Japan.

So the problem is how to provide liquidity only to the parts of society that produce things we need. Austrians want to do away with all money printing because they think all money printing is bad. This parallels them wanting to do away with “all” government because they think all government is bad. In one post above I already gave the deep theoretical underpinnings explaining why government must be used beyond rule of law. In the case of money printing, a fix quantity currency, either digital or unobtanium that came from a one-time meteorite (better than gold in an Austrian’s world), I’ve tried to explain why a commodity peg is better, and Hayak wrote a book on it. In addition, I’m not opposed to a little “keynesianism” if the commodity peg is not enough to prevent a deflationary spiral.

But the liquidity must be intelligently directed. This suggests fiscal policy. I believe in infrastructure that lowers the cost of the goods we produce, given to projects contracted out to the private sector. We should tax real estate heavily to kill the construction sector and use those workers and the taxes to build mass transit, for example. This will also deflate the 43% housing in the CPI giving more room for liquidity that can go towards real workers doing the things we need. Or for reduced SS taxes on labor that helps make our products too expensive. Let Warren Buffett pay SS. We can also do protectionism where we want to compete as all great nations have done ni the past (China is a tremendous example of where lack of neoliberalism is great for an economy). Warren Buffett says trade certificates are much better than tarriffs.

This is the end of an empire. It won’t be easy. Our population does not have a good enough economics education to allow us to escape.

Zwy, Ron Paul made a complete fool of himself in that video. Everything he said was wrong. He was wrong on facts and wrong on predictions–indeed about as wrong as a person can be. And yet the Paulistas that commented underneath seemed to assume he’d been vindicated. It’s like religious nuts who see everything proving the existence of God.

If people have blind faith that their ideas are right, and keep on believing no matter how much their predictions fail to come true, then there’s really nothing I can say.

Ron Paul is right about one thing, the inflation of the 1980s was much greater than the inflation of the 1920s. Anyone who thinks the inflation of the 1920s (which of course never happened) caused the 1929 crash and the following slump, should have predicted a Great Depression in 1988, just as Paul did. Yes, that’s the logic of the model. And the fact that it didn’t happen? What does that tell us about the validity of Paul’s model?

[…] the present article, I want to respond to a recent post “” titled “The myth at the heart of internet Austrianism” “” in which Sumner criticized the Austrian explanation of the Great Depression. I will pick apart […]

I think it’s possible that Paul would have been completely correct if it were not for dollar hegemony, which has had effects no one predicted except Michael Hudson in his popular 1972 book “Super Imperialism”. Paul’s 5 times richer than the DOW buying something that does nothing over a 40 year time frame. It seems like it has been proven by profits to be the best real-world super-macroeconomic model ever invented.

I forgot to mention that Graham wanted to help keep commodity prices even by the government purchasing and selling commodities, which has a real effect on the flow of “utlized energy” in the market as opposed to Fed open market purchases, which are a mind game to offset market mentality. The government is being left holding a worthless bag of bonds and mortgages since the economy is not going to pick back up. A commodity peg that does not actually buy the commodities could end up supporting the financial sector in the same way I was complaining about the NGDP futures peg. I don’t see why you can’t create a “real” NGDP futures market and peg that, and maybe peg it by commodity purchases (or sales). I don’t know if my references to a “real” (N)GDP are the same as what you call RGDP. By real NGDP, I mean the 60% of the NGDP that is not financialization. Overall, the objective is to get the money on main street instead of the financial street (or China), without using helicopters or price/wage controls, but to inttelligently direct the economy towards producing the things that make life better.

By reducing the 1/3 of the CPI that is useless financialization, we can have deflation in our real cost of living as prices and wages increase (1/3 the CPI). If you can get commodity prices lowered by infrastructure and government leveling of the commodities market (making it more predictable for investment), then that’s another 1/3 of the CPI that can be deflated, allowing wages to increase even more while prices stay the same.

Scott, I agree that tight money beginning in 1929 was a major causal factor in the Depression. That doesn’t exclude significant capital market distortions from (NGDP) inflation in the 1920’s as another such factor. Hayek admitted under-emphasizing for the 1930’s what he already identified as a possible deflationary component of depressions. He never disavowed the preceeding inflationary distortions.

I’d have to study the postwar case more to say for sure, but (i) one can’t take war-time aggregates at face value given the unprecedented degree of government control over the entire economy at the time, and (ii) looking at a graph of log(NGDP), it’s just wrong to say that the deviation from trend post-1945 was “far more expansionary” than the 1920’s; the post-1945 trend looks pretty close to an extrapolation of the 1933-1937 trend.

Your motivation for denying the inflationary regime shifts of 1915 and 1921, to me obvious in the NGDP data, seems to be to defend Friedman and Schwartz. But there’s no contradiction between the two. If negative NGDP surprises create harmful monetary disequilibrium, why in the world wouldn’t positive ones as well?

Zawy, To be honest it’s hard to converse with someone who uses language in a different way from everyone else. RGDP doesn’t mean non-financial GDP. And I have no idea what “useless financialization” is.

Eric, I agree that 1915-20 was very inflationary. That had nothing to do with the Fed, it was because we were on gold, and gold was rapidly declining in value. But that has no bearing on the 1930s.

I don’t see any evidence of capital market distortions in the 1920s. Some people point to things like the Empire State building, but I don’t see any reason why that wasn’t a completely rational investment.

“Financialization” is an accepted term in macroeconomics. according to Wikipedia “In the American experience, the roots of financialization can be traced to the rise of Neoliberalism and the free-market doctrines of Milton Friedman and the Chicago School of Economics, which provided the ideological and theoretical basis for the increasing deregulation of financial systems and banking beginning in the 1970s.”

It’s key to understanding what has happened since Reagan. It’s where where Austrians and neoliberals have been blind-sided.

Michael Hudson in 2003:

“They (producers) are not able to invest in new physical capital equipment or buildings because they are obliged to use their operating revenue to pay their bankers and bondholders, as well as junk-bond holders. This is what I mean when I say that the economy is becoming financialized. Its aim is not to provide tangible capital formation or rising living standards, but to generate interest, financial fees for underwriting mergers and acquisitions, and capital gains that accrue mainly to insiders, headed by upper management and large financial institutions….It has not even been mentioned [by economists] that the growth in this financial and rentier overhead has outstripped the contribution of productivity gains for most workers economic welfare.”

He wrote an excellent piece on the subject in 1998, which includes a brief history of previous thinkers. Marx was too optimistic about capitalism because he thought financial capital would be subordinate to industrial capital. Our excess capacity to produce without workers has allowed (through intellectual and economic negligence) to most people and industry being subordinate to finance without regard to improving production or lifestyle. Today’s finance does or provide capital for the sake of production or lifestyle, but actively destroys previous gains. John Hobson, Thorstein Veblen, and Herbert Somerton Foxwel wrote about it. German Rudolf Hilferding coined the term “finance capitalism” which is now considered part of “marxian” thinking, even though Marx had no idea. It had not been seen very much until England’s collapse. The level to which it controls Europe and the U.S. today is beyond all previous thinking.

An enlightening 2004 article written by an old Marxist in 2004 has a predictive nature only Austrians can approach (because Austrians are anti-government and government now is largely controlled by elements worse than “Marxian capitalists”). He says the problem goes back before 1973 but accelerated with the dollar becoming the world’s fiat (he gives a shout-out to non-Marxist Hudson).

“This could happen as an “orderly bankruptcy proceeding” but it will most likely happen (as it has always happened in the past) chaotically, through economic blowout, class confrontation, and war. … This crisis will in all likelihood not come in a “pure”, 1929-style form of abrupt deflation, stock market crash, and sudden mass unemployment (though some combination of these is a distinct possibility). What somehow has to happen, from a capitalist point of view, is a serious devaluation of the approximately $11 trillion dollars currently held by foreigners…. The dollar must be dethroned from its global reserve currency status….[The U.S.] must deflate the approximately (outstanding) $33 trillion of Federal, state, municipal, corporate and personal debt (3 times the dubious “GDP” figure) that has kept the economy going for decades. This will entail, among other things, a collapse of the huge mortgage bubble and the subsequent bankruptcy of untold millions of families and individuals.”

zawy, The financial sytem was not deregulated after the 1970s. There are enough regulations to fill an entire small library. There is massive interference in the financial system, in all sorts of ways. Many of those regulations encouraged banks to make more housing loans.

The Hudson quotation makes no sense, banks and bonds and stock markets have been around for more than a 100 years.

Eric, I have no evidence on people’s consumption preferences (nor did I even hint at such knowledge), which is why I prefer stable NGDP growth like we had in 1922-29 and from 1985 to 2007.

The stock market boomed and crashed in 1987, and the economy did fine afterwards.

He’s not referring to the existence of banks and bonds, but to the increasing role they play, outstripping advances in production, no longer serving production with capital, but by extracting capital away from it.

The Wikipedia article may be referring to the “ideological and theoretical basis” rather than the actual deregulation that I believe began with Reagan.

I was objecting to where you seemed to be over-generalizing Hudson’s position by your statement “banks and bonds and stock markets have been around for more than a 100 years”. He wasn’t saying they need to be eliminated, but that society needs to keep them in the role of providing capital to production for the benefit of society rather than using keyboard credit to extract real capital away from producers. I suppose he means we should get rid of bad laws and enact good laws where needed. For example, by making interest payments a 100% tax deduction and taxing capital gains at a lower rate, corporate raiders were (in the late 1980’s and 1990’s I believe) able to get enough leverage to take over a company and then sell off its assets to pay off the loan and interest. They profit the difference between the tax rates. The bankers win on the interest. The losers are the customers who previously enjoyed the legitimate company’s products. The same process has been happening in housing: mortgage interest deductions and capital gains roll-over strongly encourage a housing bubble. Construction has had little productivity gains in the past 60 years so it employees a lot of people, so it looked good to politicians. But it distorts market forces, diverting resources and labor away from where it is needed. Asia and latin america suffered problems that were caused by similar methods of “capital fighting capital”. Ironically, Austrians warn of these problems from government intervention, but capital fighting capital is a warning in Marxism. It is the religious belief of Austrians that government causes capital to fight capital, but it is a Marxist belief that the free market can do it on its own. I take the middle ground. The free market can have externalities, natural monopolies, and reduce evolutionarily-beneficial diversity, and it is up to government to address these problems, in addition to enforcing a rule of law for individual transactions.

Zawy, I completely agree on making the tax treatment of debt and equity equal, in order to lose loopholes, and to end the deductability of mortgage interest. I just don’t see a link to our current crisis, which is low NGDP.

Would you change your post already. You’ve been shown repeatedly that you are the internet austrian, and have a poor understanding of what you’re criticizing. Hayek is the wrong source. He doesn’t represent the Austrian School’s most valued contributions despite his winning the nobel prize from a socialist bank. The claims that you have made criticizing what you think is “internet” austrianism, but which in reality is stuff that exists in texts that you have never seen (because you go to the same stupid socialist school that i had to leave in year 3 because I couldn’t tolerate its covert marxist influence), are confused. It is clear you don’t understand the theories that the Austrian School posits. And there is nothing worse than people who criticize work they don’t understand. Shame on yo. You should read Mises and Rothbard’s books. You can buy them on the internet along with Hayek’s. But only the internet austrians (who have never read a text) believe Hayek is the real voice of the austrian school. That is the irony of your original uninformed drivel.

The broader monetary aggregates rose significantly, but the government didn’t even keep data on M1 and M2 until fairly recently. No one in the 1920s thought the Fed should be targeting aggregates that didn’t even exist.

Am I the only one who finds this totally meaningless? The fact that government wasn’t targeting M2 does not change the fact that M2 increased. Which is all that matters.

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Welcome to a new blog on the endlessly perplexing problem of monetary policy. You’ll quickly notice that I am not a natural blogger, yet I feel compelled by recent events to give it a shot. Read more...

Bio

My name is Scott Sumner and I have taught economics at Bentley University for the past 27 years. I earned a BA in economics at Wisconsin and a PhD at Chicago. My research has been in the field of monetary economics, particularly the role of the gold standard in the Great Depression. I had just begun research on the relationship between cultural values and neoliberal reforms, when I got pulled back into monetary economics by the current crisis.